Kyrgyz Republic
Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
30 Oct 2000
eISBN:
9781451821321
Language:
English
Keywords:
ISCR; CR; government; Kyrgyz authorities; banking system; Kyrgyzstan; debt service; structural adjustment; nominal wage; reform program; market economy; flat rate
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The paper describes recent macroeconomic and financial developments and highlights a number of important medium- and longer-term policy issues. Empirical estimates of potential output growth for the Kyrgyz economy based on a number of different methodologies are presented. Competitiveness and trade policy, social policy issues, namely poverty alleviation and pension reform, are also taken up for discussion. Developments in the banking system since 1998 are described. Fiscal issues are discussed and also statistical data on economic indices are presented.

Abstract

The paper describes recent macroeconomic and financial developments and highlights a number of important medium- and longer-term policy issues. Empirical estimates of potential output growth for the Kyrgyz economy based on a number of different methodologies are presented. Competitiveness and trade policy, social policy issues, namely poverty alleviation and pension reform, are also taken up for discussion. Developments in the banking system since 1998 are described. Fiscal issues are discussed and also statistical data on economic indices are presented.

I. Introduction1

1. Since independence in 1991, the Kyrgyz Republic has embarked on an ambitious program of economic reform. Although some of the policies of the former Soviet Union still prevail, the reforms that have taken place are noteworthy in two respects. First, they were both comprehensive and pursued in a fairly rapid fashion. Second, they reduced the role of government in the economy by introducing market forces, largely through mass privatization and price liberalization, and exposed the economy to competitive forces through a liberal trade and investment environment. The goal of this broad agenda was to establish a market-oriented economy and was born of the necessity to deal with the shock caused by the breakup of the Soviet Union, including its central planning, trade relationships, and importantly, the loss to the Kyrgyz Republic of budgetary transfers which had amounted to around 10 percent of its budgetary revenues.

2. With the help from the Fund and other multilateral and bilateral donors, the Kyrgyz authorities moved quickly in the initial stages of reform. As early as 1992, important changes were made to the legal framework (key business laws), most prices were liberalized, mass privatization began and the tax system was almost completely overhauled, with the introduction of a VAT and excise taxes. In 1993, a national currency, the som, was introduced, permitting the authorities to assume full responsibility for monetary policy, and which allowed for international trade to be settled in convertible currencies. In 1994, the trade regime was liberalized as export and import licensing requirements were lifted, export taxes were reduced, and a uniform import tariff of 10 percent was introduced on all non-CIS imports. Also in that year, the government embarked on a comprehensive medium-term economic and structural adjustment program (ESAF, 1994–97) with the following key elements: stabilization of the economy through appropriate monetary and fiscal policies to lay the basis for an acceleration of economic growth; restructuring of the commercial banking system; the acceleration of privatization efforts and the conversion of those state enterprises not being privatized to joint stock companies; and the strengthening of the social safety net.

3. In 1995, a number of developments lessened state control over agricultural activity. Land-use rights were extended from 49 years to 99 years and a unified land registration system was put into place. In 1996, the country was granted observer status at the WTO, and in 1997 reform of the civil service began, which entailed at the start, reducing government employment and improving efficiency through the restructuring of public institutions. In 1998, the Kyrgyz Republic acceded to the WTO and remains the only republic of the CIS to do so thus far. It also entered into a second three-year ESAF arrangement, this time with a focus on promoting private sector investment and mobilizing domestic savings.

4. Despite these reforms, recent developments, including those resulting from the financial crisis in Russia, have shown the economy to be less robust than expected. Indeed, the economy remains vulnerable to external shocks, as macroeconomic stability has not yet been achieved and foreign debt and debt service are now at worrisome levels. Moreover, there has been some slowdown in reform with the completion of small scale privatization, and much remains to be done to create a more business friendly environment, including further reduction in licensing and inspection requirements and improvements in corporate governance.

5. This paper describes recent macroeconomic and financial developments (Section II) and highlights a number of important medium- and longer-term policy issues. Section III presents some empirical estimates of potential output growth for the Kyrgyz economy based on a number of different methodologies. Sections IV and V discuss competitiveness and trade policy, while social policy issues, namely poverty alleviation and pension reform, are taken up in Sections VI and VII. Developments in the banking system since 1998 are described in Section VIII, while fiscal issues are discussed in the final section.

II. Recent Economic Developments

6. As in all of the Baltics, Russia and other countries of the former Soviet Union (BRO), output declined in the Kyrgyz Republic over the initial period of transition and did not recover until 1996. Recovery was largely driven by the start-up of production of the Kumtor gold mine, as the contribution of the emerging private sector was still small. Over the next two years, real GDP growth expanded by around 7–10 per cent per annum. This relatively favorable performance came to an abrupt halt, however, in the second half of 1998 with the financial and economic crisis that emerged in Russia and which was exacerbated by domestic fiscal slippage. In the event, the som experienced a sharp depreciation of about 30 percent in dollar terms between end-August and end-December 1998, inflation jumped and economic activity slowed down substantially. Domestic problems were further compounded in 1999 by deteriorating trade relations with Kazakhstan and Uzbekistan, the country’s most important CIS trading partners outside of Russia.

A. Moderate but Unbalanced Economic Growth

7. Economic growth in 1998 and 1999 proved rather modest compared with the previous two years. Real GDP expanded by 2.1 percent in 1998, rising to 3.6 percent in 1999. The increase in activity in the latter year was mainly due to agriculture, which contributed 4.5 percentage points to overall growth, and to a lesser extent trade and catering, as manufacturing, construction and transport and communications contracted. Agricultural production grew by nearly 9 percent while services expanded by 5 percent, thus continuing an expansion of that sector which began in the mid-1990s. To a large extent, the relative success in the service sector (in particular, trade and catering) reflects the fact that it was essentially created in the transition to a market economy and did not face the scale of adjustment from central planning (in contrast with the large state-owned enterprises in the industrial sector). The decline in manufacturing was likely due to a number of factors, such as exchange rate changes which made low-quality Kyrgyz products uncompetitive (for example, in Russia), and which disrupted regional markets for raw material inputs, and a decline in value added from the Kumtor gold mine. At the same time, economic activity softened as a consequence of punitive trade measures imposed by neighboring countries on Kyrgyz exports of cement and other construction materials.

8. Agriculture, which accounts for around 40 percent of GDP, has for the past several years been a source of underlying strength for the Kyrgyz economy. Indeed, in comparing the first half of the 1990s with the second half, only agriculture has increased its share of economic activity. The sector has benefited from favorable weather conditions and from economic reform; in particular, the freeing from controls of agricultural prices and sales, the breakup of most state and collective farms, the introduction of new mechanisms and means of financing and the extension of land use rights. Nonetheless, the expansion of output in this area has been achieved against a background of a serious decline in both the level and growth of productivity. Except for a few commodities (sugarbeet, potatoes, vegetables), yields have not increased since the mid 1990s which suggest that increased factor inputs (the extension of arable land, increase in livestock) account for this growth. Indeed, the current level of agricultural production for most commodities is substantially below that of the pre-independence period. A number of factors are likely hindering more robust growth in this sector: the lack of modern capital equipment; poor quality or lack of inputs (for example, low-yielding seeds, fertilizers and irrigation systems); financial constraints caused by poor access to credit; and the need for better land management. Overall, expansion of production throughout the economy is being hampered by the continuing problem of inter-enterprise arrears (Box 1). Accumulation of arrears creates significant impediments to progress toward market-oriented reform by, among other things, reducing transparency, promoting market inefficiency, and impacting business planning. Inter-enterprise and budget arrears typically result from both a weak regulatory framework and slow corporate restructuring.

Enterprise Arrears

Overdue payables to foreign and domestic entities, including the budget, amounted to 3 billion soms at the end of 1999, equivalent to 6.3 percent of GDP. Overdue payables rose 4 percent in real terms from 1995, when they amounted to 1.2 billion soms. Overdue payables increased in 1999, with 71 percent of the new arrears accumulated from January through September.

Since 1995, most of the arrears have been accumulated as a result of nonpayment for electricity, agricultural products, and supplies of raw materials and machines to enterprises and retail outlets. Domestic arrears accounted for about 70 percent of the total in 1999. Electricity producers and firms in the nonferrous metallurgy are the major domestic creditors of households and the industrial sector. Externally, most of the arrears are owed to suppliers of gas and oil.

Measures to reduce the stock of arrears have been limited to the imposition of fines for nonpayment of electricity by households and legal entities, including budgetary organizations (except hospitals and jails). If the entity fails to pay for a long period, the services will be disconnected. In case of gas, domestic suppliers have the right to impose fines and penalty fees for overdue payments and are permitted by law to discontinue services except for companies in certain industries, including cement, glass, and sugar.

It is a common practice to make offsets for payments due among budgetary organizations, energy companies, and telecommunication providers. These offsets result in lack of transparency and limit the ability of the government to meet other cash expenditures.

Enterprises and Organizations Arrears

(In millions of soms; end-of-period)

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Source: National Statistical Committee.

9. Over the first half of 2000, real GDP is estimated to have increased by 7.4 percent, again supported by agriculture (which expanded by 11 percent) and a rebound in the construction sector. Preliminary indicators also point to some growth in the manufacturing sector.

B. A Rise in Inflation

10. At least until the onset of the Russia crisis, the monetary authority had achieved a measure of success in reducing inflation. Following tight monetary conditions during 1997 and 1998, inflation dropped from around 32 percent in 1996 to just over 10 percent in 1998.

11. During 1999, however, consumer price inflation accelerated, reaching 40 percent by year-end. A number of factors occurring through the year contributed to this outcome. First, price developments were affected by large liquidity injections in April and July; moves designed to limit the issuance of treasury bills and not roll over part of the maturing reverse repos, and rapid repayment of budgetary arrears. Second, increases in excise tax rates and tariffs for electricity and hot water in the first half of the year are estimated by the National Bank of the Kyrgyz Republic (NBKR) to have added more than 14 percentage points to the rise in the consumer price index. Third, increased prices for both (imported) oil products and grain and flour2 had a large impact on the outcome (estimated around 40 percent), because of their weight in the consumption basket. In the case of grain, price developments were affected by shortages and a drawdown of state reserves used for payment of gas arrears to Uzbekistan. Finally, the nominal effective exchange rate depreciated by more than 13 percent over the 12–month period. Given that the share of imports in GDP is around 45 percent, the pass through of this depreciation would itself add 6 percentage points to annual inflation.3

12. During the last quarter of 1999 and into 2000, one of the goals of monetary policy was to reduce inflation by withdrawing liquidity resulting from the repayment of budgetary arrears. So far, there has been some success in this regard, as base and broad money grew by only 5 percent over the first half of 2000. This, combined with relative stability of the exchange rate has led to a dramatically improved inflation performance. Indeed, consumer prices rose by only 7.1 percent over the first half of this year, which is the best outcome for a comparable period since 1990. Price developments so far this year were influenced by the impact of tariff increases for electricity and natural gas, and increases in the price of fruits and vegetables early in the year.

C. Wage Developments and the Labor Market

13. In 1998, the minimum wage (to which certain wages, social benefits and tax rates are indexed) was raised to som 100 per month and it has remained at that level. With the acceleration of inflation in 1999, the real minimum wage declined by around 26 percent while average real wages fell by around 10 percent. Over the first 5 months of 2000, average real wages began to recover.

14. The average nominal wage in May 2000 was som 1,070 per month (or just over $22). Compared with the situation in 1998 and with other areas, nominal wage gains have recently been made in the transport and communication, construction and agricultural sectors, although in the latter case, wages remain less than two-thirds of the industrial average. In 1999, the highest salaries were received in finance and insurance (som 3,193 per month), communications (som 2,076), and industry (som 1,579), while the lowest were in education (som 605), culture and the arts (som 563), and forestry (som 418). At the beginning of August, public sector wages were increased, on average by 20 percent, bringing them closer into line with those of the private sector.

15. The expansion of output over the past two years has been accompanied by a small rise in recorded employment. Over the period 1998–1999, the growth of employment was 1.7 percent, which added 29,000 jobs to the economy. From a sectoral point of view and reflecting the unbalanced nature of economic activity of late, job gains accrued mainly in agriculture, with a slight increase in the service sector. In contrast, the number of workers in industry, construction, and transport and communications fell by 42,000 and their share of total employment now accounts for around 15.4 percent, in comparison with agriculture with a share of nearly 52 percent.

16. Over the past several years, the working-age population has grown relatively quickly, and this has resulted in a similar rise in the labor force. In 1998, the latter grew by 1 percent, reaching 2.4 percent in 1999. Employment growth has not kept pace and consequently, unemployment has increased. Total unemployment, defined as the labor force less total employment, reached 137,000 in 1999, or 7.4 percent when expressed as a ratio of the labor force. This is well above the “official” measure of unemployment, which only takes account of those registered with the employment service.4 However, the total unemployment rate is itself biased downward, since the measure of total employment includes those employees who have been required by their employers to undertake administrative or vacation (unpaid) leave. Indeed, the World Bank-supported annual household surveys suggest that the “true” rate of unemployment is probably much higher at around 20 percent.

17. The lack of employment opportunities is a serious problem in the Kyrgyz Republic for a number of reasons. First, there are few sources of alternative income and there is not a strong social safety net. A substantial portion of the population thus relies on subsistence farming to survive. Second, it appears that the rise in unemployment is mostly structural in nature and signs of distress in the labor market abound: unemployment in urban areas is on the rise even though much of the industrial sector which is located in these areas has so far resisted structural change that would result in more pronounced layoffs; the share of long-term unemployment (more than one year) in total unemployment is estimated to have climbed; and young people (aged 16–29 years) account for one-third of the unemployed. Without substantial growth in employment over the medium term, efforts to reduce the high level of poverty will likely fail (see Section VI below).

D. External Sector Developments

18. The impact of the financial crisis in Russia on the Kyrgyz Republic was felt most heavily in the external sector, with the current account deficit rising to nearly 20 percent of GDP in 1998. In 1999, the deficit fell to slightly more than 16 percent of GDP (or $200 million). The trade deficit declined to $84.4 million in 1999 from over $170 million a year earlier. This improvement was largely due to a slump in import demand (by 25 percent) as the som depreciated in real terms: this was larger than the drop of exports (by 19 percent) caused by trade barriers erected by the country’s major trading partners (Kazakhstan and Uzbekistan) and by supply constraints in export-oriented activities (light industry, glass). Kyrgyz exports of food stuffs, cement and other building materials to Kazakhstan were virtually halted in 1999 as punitive tariffs were imposed. At the same time, trade with Uzbekistan has been interrupted by frequent border closings and the imposition of high excise taxes on goods from the Kyrgyz Republic. Trade with Russia also suffered both as a consequence of the decline in activity in that country until recently, and difficulties with transporting goods through neighboring countries. However, since the end of 1999, progress has been made in removing some of the intra-regional tariff barriers that were in place through most of 1999, but a number of non-tariff barriers remain, for example, licensing fees for some key products, as well as ecological fees (imposed at the oblast level) for transit through Kazakhstan. A narrowing of the services deficit also contributed to the improvement of the current account. In 1999, the services deficit registered $93.5 million, which was $24 million lower than a year earlier.

19. Exports of goods and services declined by 13 percent in the first quarter of 2000, compared with a year ago. A reversal of this situation is expected in the near term, given both the recent improvement in the country’s international competitiveness (see Section IV below) and regional trade relations. The real effective exchange rate has depreciated slightly (2.5 percent) over the course of last year, and into the first few months of this year. Over the same period, the decline in imports slowed to around 7 percent. Overall, there was a small improvement in the current account of the balance of payments.

20. At present, exports are limited both in scope (mainly gold, electricity, tobacco and some agricultural products) and direction, with pre-independence trade patterns (except gold) still prevalent (see Section V). Thus, the authorities are making efforts to diversify and expand the export base. Gold production from the Kumtor gold mine accounts for nearly 40 percent of exports (and 10 percent of GDP). This mine has operated since 1997 but production is expected to end in 2008 (Box 2).

The Kumtor Gold Mining Project

In May 1997, the Kumtor Operating Company, which is two-thirds owned by the Kyrgyz Republic and one-third by Cameco, a Canadian company, began gold mining operations in a remote and mountainous area of the Kyrgyz Republic. The construction of the mine cost $450 million, there was an initial estimate of 16.5 million troy ounces of gold resources (based on a gold price of $350/ounce), and gold production was expected to average around 485,000 ounces a year over the life of the project.

In the event, probable reserves were scaled back to around 9 million ounces as production began.1 Kumtor currently employs over 1,150 employees, of which 90 percent are Kyrgyz nationals. Cumulative gold production during the first three years of operation was 1.755 million troy ounces with an average cost of around $175/ounce.

In December 1999, the company revised its business plan to account for a number of factors: changes in the price of gold; experience it has gained in operating the mine; and changes to its geological model of the resource base. This plan assumes a gold price of $310/ounce, with the effect of substantially lowering the remaining reserve base to around 4.27 million troy ounces of gold. The following production schedule is envisioned: 649,000 ounces in 2000; 665,000 in 2001; 680,000 in 2002; 716,000 in 2003; 350,000 in 2004, 400,000 in 2005, 250,000 in 2006; 136,000 in 2007; and the mine being decommissioned in 2008. The revised, and accelerated production schedule, not only reflects the lower price of gold, relative to the initial plan but also the desire to retire debt quickly. According to Company officials, Kumtor’s debt should be retired in 2003. The authorities were informed of this revised business plan in early 2000.

1 A great deal of confusion has existed about the extent of the reserve base. The authorities have, until recently, been under the impression that the reserve base is close to the initial estimate provided in the mine-feasibility study (16.5 million ounces). According to the company, however, this figure is related to total resource rather than the reserve base.

21. The capital account surplus was reduced by around $46 million to $234 million in 1999 despite higher net borrowing, due to a drop in foreign direct investment. The contraction of (net) foreign direct investment to $44 million in 1999 from above $100 million in 1998, is a cause for concern. While gross foreign direct investment reached more than $109 million in 1999, there was an outflow of nearly $65 million. The nature of this outflow is not fully understood at this time, however, there are indications that existing projects may have been scaled back or cancelled in the trade and catering sector, procurement agencies and the banking sector. Loan disbursements were higher ($28 million) than a year ago and were almost exclusively to the government. Amortization payments (including by Kumtor) remained at around $53 million.

22. The overall balance of payments was in surplus by $19.5 million in 1999. This allowed the NBKR to add $53 million to its gross international reserves, which increased from just over 2 months to over 3 months of import cover. Exceptional financing in 1999 equaled $22.2 million, which wholly represented arrears to Russia, Pakistan, India and Germany. Arrears totaling nearly $15.8 million were also incurred in the first quarter of 2000 on payments to Russia, Pakistan, India and Turkey. Nonetheless, mid-year, the authorities were successful in agreeing in principle, with Russia, Pakistan and Turkey on a debt rescheduling.

23. External debt indicators worsened in 1999. The external debt-to-GDP ratio increased from around 72 percent in 1998 to 112 percent a year later, while the net-present-value of the debt-to-export ratio remained at around 130 percent. This build-up of debt during the past few years reflects a number of influences; a certain lack of fiscal discipline, with deficits averaging about 12 percent of GDP during the past 5 years; a shortage of private sector savings; and a willingness of bilateral and multilateral financial institutions to finance the large fiscal deficits and an expanding public investment program.5 Although much of the newly contracted debt is on highly concessional terms, the debt service profile for the medium term is very difficult.

24. At the end of 1999, the stock of public external debt stood at $1,374 billion6, of which $911 million was owed to multilateral institutions, mostly on a highly concessional basis. A total debt of around $200 million is owed to the IMF, representing purchases under a stand-by arrangement, the systemic transformation facility in 1993–94 and ESAF. Bilateral debt amounted to $462 million for which the Russian Federation ($173 million) and Japan ($157 million) are the largest creditors. Debt service payments (excluding Kumtor) amounted to $41.6 million in 1999.

E. Macroeconomic Policies

Fiscal policy

25. Fiscal policy is, and has been, perhaps the weakest pillar in the economic policy framework and, given the relative size of the government, this has adversely affected overall economic performance. This weakness is due to a number of factors. On the revenue side, the Kyrgyz Republic has been and remains one of the poorest countries of the former Soviet Union and as such, it had relied heavily on transfers to supplement its own revenue sources. In the transition to a market economy, these revenue sources have not been very strong as a result of slow growth, weak tax administration and distortions in the tax structure which have contributed to a significant amount of underground economic activity.7 On the expenditure side, the weaker fiscal revenues have led to severe cuts in current expenditures, although there has been an ever growing public investment program and an attempt to maintain pre-independence levels of social services, support of the poor, and health and education. Fiscal outcomes have also been heavily influenced by relatively little progress in dealing with some of the important budgetary issues (for example, deciding on the appropriate size of the government, the optimal level of energy prices, and dealing effectively with certain large delinquent tax payers) and poor budgetary management, and a lack of transparent rules and legislation.

26. In 1998, the overall cash deficit of the central government amounted to 9.5 percent as a share of GDP, rising to 12.0 percent in 1999. Over the same period, a primary deficit (excluding the foreign-financed private investment program) of 1.7 percent of GDP turned into a surplus of nearly 0.5 percent. Part of the widening of the cash deficit in 1999 was a result of unforeseen expenditures related to an incursion of foreign terrorists in the south of the country in the second half of the year.8 Cyclical elements were also at work, as output declines in industry and a drop in imports and a shift in import patterns (an increase in the share of imports originating in Russia and thus not subject to customs duties or VAT),9 all contributed to lower-than-expected revenues. Compared with 1998, the ratio of (cash) tax revenues-to-GDP fell in 1999 by 1.6 percent. Structural elements also played a part, as recurrent administrative problems in tax collection and an increase in foreign-financed project spending worked to boost the deficit in the same direction. Capital spending increased by more than 3 percentage points of GDP in 1999. Current expenditures, however, were reduced, falling by around 2 percent of GDP, with wages and Social Fund contributions facing the largest cuts. (Developments concerning the Social Fund are discussed in Section VII below). Non-wage health and education expenditures also experienced retrenchment.

27. Difficulties with expenditure control, together with revenue shortfalls, led to the accumulation of large expenditure arrears in the first half of 1999. However, most of these arrears were paid off in July and at year end, the stock of domestic arrears amounted to around 0.5 percent of GDP.

28. During the first half of 2000, the fiscal situation remained difficult. Parliament rejected several tax measures and revenues initially fell short of expectations. However with the improved economic growth, revenues picked up subsequently and expenditure arrears were eliminated. The government also implemented several measures to improve expenditure management and current expenditures were contained. In particular, they began establishing monthly financial plans and set monthly cash limits, with a view to complying with the IMF’s Minimum Standard on Fiscal Transparency.

Monetary and exchange rate policies

29. The implementation of monetary policy in transition economies remains a challenge, and the Kyrgyz Republic is no exception. These challenges stem from a number of factors. First, the environment is highly uncertain, given the policy changes and structural adjustment that are going on. Second, the low monetization of the economy and lack of financial intermediation, combined with a paucity (until more recently) of monetary instruments, has potentially limited the NBKR’s influence over economic activity. Third, monetary policy has been complicated by the fiscal stance. With continued high fiscal deficits and the build up of debt, the monetary authority has had to lean against the wind for much of the post-independence period.

30. A key issue in the conduct of monetary policy has been the erosion of the demand for soms. Since mid-1998, the domestic financial crisis, stemming in part from domestic factors, has created pressures on and undermined confidence in the domestic currency following several years of relative stability. The loss of confidence was aggravated by severe problems in the banking system which led to the closure of several of the country’s largest banks (Section VIII). Public confidence in the currency will only be re-established by concerted efforts by the NBKR and the government.

31. The implementation of monetary policy during 1999 and into 2000 has been uneven, although the underlying forces for this unevenness lay beyond the control of the monetary authority. Over the first half of 1999, monetary conditions were relatively tight, while over the ensuing six months conditions loosened substantially, only to be reined in over the first few months of 2000. The switch in monetary conditions reflected: the continuing influence of the Russia crisis which contributed to the problems in the banking sector; a decision by the government to repay budgetary arrears in mid-year; and actions by the NBKR to withdraw the excess liquidity resulting from budgetary repayments. In the event, broad and reserve money grew by 34 percent and 23 percent, respectively in 1999. In the first half of 2000 these aggregates expanded by 5 percent as the NBKR continued with the tight policy stance it adopted at the start of the year.

32. After much of the difficulties of 1998 passed, the key central bank rates were lowered in the first quarter of 1999 to 32 percent, being halved from the levels reached at the height of the Russian crisis. However, with subsequent pressures on the exchange rate mounting, linked in part to the floating of the Kazakh tenge, both the discount (prime interest) and Lombard rates were again raised to levels similar to those prevailing six months before. Indeed, with further pressures on the exchange rate over the rest of the year (due to liquidity injections and problems in the banking sector, mentioned above, as well as seasonal influences), the discount rate was raised even further, ending 1999 at 55.1 percent, thus surpassing the highs of August 1998; although the Lombard rate at 62.4 percent, ended 1999 at a somewhat lower level. With the stabilization gaining ground, both of these central bank rates had been brought down steadily to around 28 percent by the end of June 2000. Meanwhile, the benchmark interest rate on three-month treasury bills remained above 50 percent for most of 1999 but it too fell since then to around 16 percent. Interest rate developments on credits extended by the banking system tracked the general interest rate trend, although they currently remain at a much higher level (71 percent) and the spread (around 34 percentage points) between loans extended in U.S. dollars versus soms is above that prevailing in the pre-crisis period.

33. In 1997, the som, exhibited a remarkable degree of stability, fluctuating within a relatively narrow band of 17–17.5 soms per U.S. dollar throughout the year. However, for the reasons mentioned earlier, including the Russia crisis, by the end of 1998 it had fallen to 29.4 som per U.S. dollar. Over the course of 1999, despite significant intervention by the NBKR, it depreciated still further as domestic and external events continued to undermine confidence in the currency. In total, the depreciation amounted to more than 55 percent over the year and the som was valued at 45.95 per U.S. dollar at year end. However, the pace of depreciation began to slow in the latter part of 1999 and into 2000. In June, the som stood around som 47 per U.S. dollar.

34. Over time, the NBKR’s monetary policy framework has been strengthened and a number of further refinements were recently adopted. The most important of these developments is the introduction of National Bank Bills in June 2000. The main purpose of the NBKR notes issue is to establish a “clean” instrument for monetary policy to manage the money stock, that is separate from the exigencies of managing the state’s debt. Moreover, the market for these latter securities is relatively thin. NBKR notes will complement the T-bill market by having shorter maturities (7, 14 and 28 days); by having a substantially larger face value (som 10,000 versus 100 for T-bills); and by focussing its market towards commercial banks or other large investors. Reserve requirements have remained unchanged at 20 percent, however, the compensation paid on bank’s required reserves has been steadily reduced. In the past, the NBKR fully compensated banks for required reserves at the rate of each respective bank’s weighted average cost of deposits. The level of compensation is now only 55 percent. Minimum capital requirements were raised in August to som 50 million.

F. Structural Reforms

35. Since 1991 the implementation of structural policy measures has progressed to an advanced stage in a few areas, in others some changes have occurred, while in many areas much unfinished business remains. Price liberalization, trade policy and mass privatization are areas where policy makers have achieved a measure of success. The Kyrgyz economy is among the most open of the CIS countries, the more so, if account is taken of their WTO-obligations to reduce already low tariff barriers even further. With regard to small-scale privatization, more than two-thirds of formerly state-owned enterprises are now in private hands.

36. Some progress was made to further liberalize the economy during 1999 and the first half of 2000, these involved: small-scale privatization; regulatory reform; and public sector reform. Significant developments also occurred in the areas of pensions and trade policy, and these are discussed in greater detail below.

37. Small-scale privatization continued in 1999 and early 2000, as 178 state-owned enterprises were transformed, some into joint-stock companies, while others were sold directly. However, there was little progress toward divesting interests in the large state-owned monopolies. An international tender for the sale of a 40 percent stake in Kyrgyz Telecom took place, although it was declared void because of the lack of properly filed bids. (A second tender is due to take place shortly.) In the energy sector, a restructuring and reform plan for KyrgyzEnergo has been adopted with a view to dividing the electricity concern into three separate companies engaged in generation, transmission and distribution, in line with the Action Plan for the World Bank adjustment credit. In addition, a financial adviser was selected to guide the development of the distribution sector. An important part of this reform involved tariff changes, and in this regard, electricity prices were raised in January and April of this year by a combined 40 percent.10

38. With regard to regulatory reform, a draft law has been submitted to parliament that reduces the number of activities requiring licensing from 62 to 32. The practice of sublicensing has been declared illegal and efforts have been made to reduce excessive inspections by limiting the number of bodies allowed to undertake them. In addition, inspections and pre-inspections for international trade, with the exception of alcohol, are no longer required. Further simplification of licensing procedures is awaiting approval of the above draft law.

39. With regard to public sector reform, at the beginning of this year, the government implemented several measures to streamline a few activities at the local level. In a number of departments, activities were either abolished or transferred to oblast state administrations (for example, agriculture, education and culture, health). To improve financial control, the State Inspection and Financial Control was merged with the Chamber of Accounts (public auditor). The transfer of these functions to the oblast level resulted in some cost savings and a small reduction in personnel. In addition, reforms (in particular, staff reductions) to the Ministry of Internal Affairs and of Foreign Affairs have been approved. Further measures aimed at other ministries are being contemplated along side a more comprehensive reform of the entire sector, which should be put in place in 2001.

III. Potential output growth over the long term11

40. Estimates of a country’s potential output—the maximum output which can be sustained without a rise in inflation—and the position of output relative to this potential are important considerations in assessing and formulating economic policy requirements. While central to the analysis of industrial countries, this concept is also relevant for transition (and developing) economies to better understand the supply-side determinants of growth as the transformation process proceeds. Estimates of the gap between potential and actual output (the output gap) give an indication of the degree of slack in the economy at a point in time, and thus provide a means of both looking through cyclical developments to identify emerging structural imbalances in the macroeconomy and to identify underlying inflation pressures. They also have an important use in analyzing fiscal developments and the underlying structural budget balance.

41. In this section, an attempt is made to estimate medium-term potential output and the output gap for the Kyrgyz Republic. It is important to note that, since these variables are unobservable and there is no satisfactory method for deriving them, they are surrounded by a wide margin of uncertainty, and should be interpreted cautiously.12 In the next section, the methodological issues in constructing potential output are discussed, followed by estimates for the Kyrgyz Republic. A final section looks at the impediments to faster growth, suggested by the analysis.

A. Methodological and Data Issues

42. A number of methods can be used to gauge an economy’s trend or supply-determined potential output. These methods include, the use of time trends, univarate de-trending approaches such as the Hodrick-Prescott (HP) filter, a production-function based approach, and indirect methods which rely on cross-sectional, rather than time series data.13 The use of time trends (or split time trends) involves regressing the log of real GDP against time, or split time trends, to allow for differences in trends between cycles. While the advantage of this method is its simplicity the main disadvantage is that it imposes a deterministic trend, which is not evident in some of the data. The HP filter improves on the time trend by fitting a trend through the observations of real GDP, irrespective of any structural breaks in the data, but allows the regression coefficients to vary over time. This is accomplished by searching for a trend output that both minimizes a weighted average of the gap between output and trend output, at any point in time, and the rate of change in trend output at that point in time.14 The benefit of this approach is that it only requires data for real GDP, while a drawback is the arbitrary nature of the weighting (or smoothing) factor.15

43. Unlike the mechanical nature of the previous methods, the production function based approach attempts to explicitly account for potential output by linking it directly to factor inputs, and the linkage between them and total factor productivity. Several steps are involved. A production function is estimated (typically Cobb-Douglas) for given shares of capital and labor, the residuals of which are then smoothed and used as a measure of trend total factor productivity. A measure of potential employment is then defined, consistent with the natural rate of unemployment or the employment level that does not result in additional inflation (i.e., the nonaccelerating wage rate of unemployment, or NAWRU). (Below, for simplicity and lack of knowledge about the nature of the labor market, trend employment using the HP filter is used in deriving this estimate.) The smoothed measures of total factor productivity and employment are then combined with the actual capital stock in the estimated production function to determine potential output. The main advantage of this approach is that it allows for an explicit accounting for growth in terms of what is known or assumed about factor inputs and productivity, and allows for judgement to be brought to bear on some of the key elements. A major drawback remains the significant data requirements used in its construction. Much of the data are difficult to measure, and when available are often unreliable (capital stock). Furthermore, some of the data are unobservable, and so estimating them poses similar problems as for the two other approaches.

44. A fourth approach might be better suited for transition economies because of the lack of long time series and reliable data. Under this methodology, potential growth is estimated based on the long-term growth experiences of a large number of other countries. The determinants of growth (such as human capital, population growth, investment, and public consumption) in a cross section of countries is then used to make predictions for a specific country.16 Previous estimates of Barro (1991) and Levine and Renelt (1992) are used in this regard. The major criticism of this method is that it assumes homogeneity of the growth process across (rich, middle-income and poor) countries. Since the growth process is often characterized by catch-up and technological progress, this may be a significant limitation of this approach.

45. Given the strengths, weaknesses and uncertainties attached to each of the various methodologies, a range of estimates of Kyrgyz potential output are generated below. Three of the four approaches are employed, leaving aside the (split) time trend since no assumptions were made about the nature of structural breaks in the time series.

46. The data used come from De Broeck and Koen (2000), who provide a time series for the Kyrgyz Republic dating back to 1970. Included in this data set is the capital stock, employment and estimate of both official and adjusted real output. A listing of the data is given in Table 1. Although these data stretch back into the period prior to independence, they are thought to provide insights into current developments, mainly because the structure of the Kyrgyz economy has not changed significantly, despite the recent institutional and other policy changes. However, this may be a highly erroneous assumption, given that a market economy has replaced central planning.

Table 1.

Kyrgyz Republic: Estimates of Labor, Capital Stock, and Output, 1970-97

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Source: De Broeck and Koen (2000).

Capital stock and output are measured in “comparable” prices which only partially reflect inflation. These variables are reported at constant, 1973, prices.

B. Estimates of Potential Output

47. Three different estimates of potential output over the period 1971–99, are presented in Tables 2 and 3. Several scenarios of the transition process are offered in the estimates, in order to provide a range for potential growth.

Table 2.

Kyrgyz Republic: Estimates of Potential Output Using Cross-Country Approach, 1991-99

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Source: International Monetary Fund, International Financial Statistics, and World Bank.

Barro equation: per capita growth = 0.0302 - 0.0075*initial income + 0.025*primary school enrollment rate + 0.0305*secondary school enrollment rate - 0.119*share of government expenditure in GDP.

Levine and Renault equation: per capita growth = -0.83 - 0.35*initial income -0.38*population growth + 3.17*secondary school enrollment rate + 17.5 * investment share of GDP.

Table 3.

Kyrgyz Republic: Estimates of Potential Output Using Hodrick-Prescott Filter and Production Function Approaches, 1970-99

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Source: IMF Staff Estimates and De Broeck and Koen (2000).

Over the period 1992-1999, the growth of potential output is estimated as the average rate of growth of output over the period 1970-1991.

Trend average estimate is based on smoothed (using the Hodrick-Prescott filter) labor and total factor productivity growth.

The optimistic scenario assumes both a rapid adjustment of labor resources and an improvement in total factor productivity growth over the period of transition.

The pessimistic scenario assumes both a slow adjustment of labor resources and a slow recovery of total factor productivity growth over the transition period.

48. Not surprisingly, long-run growth predicted from the cross-country approach provides the highest estimate of potential output growth, and the production function approach (under certain assumptions) the lowest.17 Using the parameters from large cross-country regressions and applying them to Kyrgyz data suggest that long-run growth in this country might be between 3–6 percent per annum. Meanwhile, the production function estimate ranges from around 2 percent to 3 percent, the upper bound being similar in value to the HP filter technique.18

49. While estimates of the rate of potential output growth vary significantly under different approaches, all scenarios indicate that the magnitude of the corresponding output gap is large, perhaps, as much as one-third of potential GDP. The potential growth estimate provides an indication of how fast the gap is likely to close over time. Given current projections for the growth of real GDP over the next several years, the upper bound estimate of potential output growth suggests that the output gap is unlikely to be closed quickly, and could perhaps widen over time.

C. Impediments to Higher Potential Growth over the Long Term

50. As noted earlier, estimates of potential output are subject to wide margins of uncertainty. Nonetheless, they can provide important insights into the nature of the growth process and policy requirements in the period ahead. All things considered, a reasonable estimate of potential output growth for the Kyrgyz economy is likely to be around 3 percent per annum. This relatively low estimate (relative to prior expectations about the positive impact of economic reform), and the magnitude of the output gap suggest a sense of urgency in eliminating the impediments to higher growth. From the point of view of the supply side (i.e., aggregate production function) a number of policy issues present themselves.

51. First, closing the output gap is a high priority, since idle capacity could translate into lower future potential growth as both physical and human capital deteriorate. Aggregate demand could be stimulated through further progress in macroeconomic stabilization and in particular adoption of a fiscal policy stance that allows for the accumulation of savings over time; and enhancing export markets and performance, since the Kyrgyz economy lacks the size to lift growth substantially through domestic demand alone. Indeed, the Ministry of Finance estimates that one third of all enterprises are idle. Furthermore, agricultural output (as noted above) is in many areas only a fraction of its pre-independence level.

52. Second, while the existence of highly educated labor inputs is often cited as a positive factor in evaluating future prospects, there is growing evidence of a rapidly deteriorating labor market. On the one hand, there is overall inadequate demand for labor, although demand does exist for technically-qualified personnel. On the other hand, labor supply remains unresponsive to market conditions, with a continuing stream of secondary- and university-trained graduates who are not technically competent. Thus, while the labor force expands in quantitative terms, it may not be rising in effective (or qualitative) terms. In this regard, important reforms to the education sector need to be made.

53. Third, the current capital stock is in a state of disrepair, and is likely having a disproportionately large adverse impact on potential output growth. For example, capital expenditures in the energy sector have not kept pace with energy sector demands; the transportation infrastructure is in disrepair (although multilateral institutions are providing support for major improvements); the telecommunications network is in need of substantial investment; the national airline has almost no capacity to service international routes; and agricultural growth is hindered by poor irrigation infrastructure and lack of modern machinery and other capital inputs. Upgrading the infrastructure will require some public capital expenditures, however, a number of these investments could be made by the private sector, if these activities were privatized.

54. Finally, it is difficult to be definitive about why economic performance in the Kyrgyz Republic has not improved more, given the extent of economic reform that has occurred since the early 1990s. A number of factors could have had some influence: the long time it takes for economic behavior to change and adjust to new policies and incentives; the coincidence of macroeconomic stabilization and structural reform leading to the displacement of both capital and labor; the still limited extent of structural adjustment that has taken place in an number of important areas (such as the labor market, export markets, and the public sector); the ongoing nature of reform; the geographic location of the country and its small size, which limits the scope for efficiency gains; and the difficulties in establishing smooth trade relations within the region. Moreover, the lack of successful implementation of a number of policies (large-scale privatization, public sector and regulatory reform, and stabilization) may also have played a role.

55. Achieving a major improvement in total factor productivity growth is predicated on both boosting capacity utilization and improving the efficiency of resource use. This might be accomplished through a concerted policy effort to set conditions right for achieving a sustained improvement in economic performance. On the macro front, fundamental changes will be required to put the budget on a sustainable basis, reduce the debt burden and to eliminate activities which place a drain on the public purse (such as ongoing problems in the energy sector and loss-making state-owned enterprises).

56. On the structural front, there appear to be four major policy challenges to confront: (i) creating incentives for investments in both physical and human capital, not through tax exemptions or transfers, but through establishing a level playing field for all economic agents which is free from excessive government intervention; (ii) ensuring that the business environment is supported by adequate infrastructure (transportation, energy, communications), which can only be provided by the public sector; (iii) further reducing the involvement of government in economic activity; and (iv) avoiding backtracking on policy reform, to remove any uncertainty as to what might come next.

IV. International Competitiveness19

57. This section examines developments in international competitiveness for the Kyrgyz Republic over the period 1995–99. The focus of attention is on the evolution of the real effective exchange rate (REER), certain key bilateral exchange rates, and relative unit labor costs (RULC’s).20

A. Estimates of the Real Effective Exchange Rate

58. The real effective exchange rate is defined as the weighted average of the real exchange rates of the country’s trading partners. As shown in Table 4 and Figure 1, the evolution of the REER can be divided into four periods.21 First, a large real effective depreciation occurred over 1995 and 1996, with the CPI- and PPI-based series broadly following the same pattern.22 Second, a modest appreciation occurred in 1997 and continued into mid-1998, with the CPI- and PPI-based series again following similar paths. Third, in the wake of the Russian crisis, the CPI-based REER depreciated by nearly 18 percent from September to November 1998 while the PPI-based series, after a sharp appreciation between July and September 1998, also depreciated, but by a lesser degree than the CPI measure. Finally, over the course of 1999, the two series diverged. The CPI-based REER showed a slight appreciation in early 1999 followed by a depreciation before stabilizing at its end-1998 level. In contrast, the PPI-based REER appreciated sharply immediately following the Russian crisis and only began to depreciate in March 1999. Overall, the som depreciated by some 19 percent, in real effective (CPI-based) terms, between September 1998 and March 2000.

Table 4.

Kyrgyz Republic: Real Effective Exchange Rates, 1995-2000

(Jan. 1995=100)

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Sources: Kyrgyz authorities; and Fund staff estimates.
Figure 1.
Figure 1.

Kyrgyz Republic: Real Effective Exchange Rate, January 1995 - March 2000 1/

(January 1995 = 100)

Citation: IMF Staff Country Reports 2000, 131; 10.5089/9781451821321.002.A001

Source: Kyrgyz authorities; OECD; and Fund staff estimates.1/ An increase indicates an appreciation.
Figure 2.
Figure 2.

Kyrgyz Republic: Real Effective Exchange Rate, 1995-2000

(Jan. 1995=100)

Citation: IMF Staff Country Reports 2000, 131; 10.5089/9781451821321.002.A001

Sources: Kyrgyz authorities; and Fund staff estimates.

59. To try to disentangle the effects that fluctuations in the currencies of the Kyrgyz Republic’s trading partners have had, key real bilateral exchange rates are presented in Tables 5 and 6 and Figures 3 and 4. Figure 3 presents the CPI-based real exchange rate index vis-à-vis Russia, Kazakhstan, Uzbekistan, Germany, and the US. The evolution of these bilateral rates sheds some light on the pattern of the REER. The real effective depreciation over the period 1995–97 was caused mainly by a depreciation of the som vis-à-vis the currencies of the Kyrgyz Republic’s major BRO trading partners. The real effective appreciation over the course of 1997 and the first half of 1998 was clearly due to a steep real appreciation vis-à-vis the German mark. Finally, the sharp real effective depreciation that occurred in the wake of the Russian crisis is mirrored by a real depreciation against four of the five currencies, the exception being the Russian ruble. The som appreciated in real terms against the Russian ruble after the Russian crisis and, as of March 2000, had not yet returned to its pre-crisis level.

Table 5.

Kyrgyz Republic: CPl-Based Key Bilateral Real Exchange Rates, 1995-2000

(Jan. 1995=100)

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Sources: Kyrgyz authorities; and Fund staff estimates.
Table 6.

Kyrgyz Republic: PPI-Based Key Bilateral Real Exchange Rates, 1995-2000

(Jan. 1995=100)

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Sources: Kyrgyz authorities; OECD; and Fund staff estimates.
Figure 3.
Figure 3.

Kyrgyz Republic: CPI-Based Real Exchange Rate Index, January 1995 - March 2000 1/

(January 1995 = 100)

Citation: IMF Staff Country Reports 2000, 131; 10.5089/9781451821321.002.A001

Sources: Kyrgyz authorities; and Fund staff estimates.1/ An increase indicates an appreciation.
Figure 4.
Figure 4.

Kyrgyz Republic: PPI-Based Real Exchange Rate Index, January 1995 - March 2000 1/

(January 1995 = 100)

Citation: IMF Staff Country Reports 2000, 131; 10.5089/9781451821321.002.A001

Sources: Kyrgyz authorities; OECD; and Fund staff estimates.1/ An increase indicates an appreciation.

60. Figure 4 presents the PPI-based real exchange rate index vis-à-vis Russia, Kazakhstan, Uzbekistan, Germany, and the US. It is striking that the PPI-based real exchange rate indices show far less fluctuation in the early years than the CPI-based ones. Although there was a steady real depreciation of the som against the Russian ruble and the Uzbek sum prior to the Russian crisis, it depreciated much less in real terms against the Kazakh tenge and faced less fluctuation against the German mark and the US dollar. In addition, the real depreciation vis-à-vis the Kazakh tenge, the Uzbek sum, the US dollar, and the German mark following the Russian crisis was far less severe when the real exchange rate is measured using the PPI rather than the CPI. Thus, although the som did appreciate in real terms against the Russian ruble, the Kyrgyz Republic experienced an improvement in competitiveness against the currencies of its other major trading partners.

61. Although such an improvement in competitiveness is usually followed by an improvement in exports (with a lag), the Kyrgyz Republic has not yet experienced it. Export growth has slowed in recent years as a result of low demand in the BRO countries, the loss of competitiveness vis-à-vis Russia, and trade tensions with Kazakhstan and Uzbekistan. Imports have also slumped, as expected, due to the real effective depreciation.

B. Relative Unit Labor Costs

62. Estimates of relative unit labor costs are shown in Table 7.23 The Kyrgyz Republic experienced an improvement in its competitive position against nearly all of its major BRO trading partners, the exception being Tajikistan. This view is also supported by absolute measures of competitiveness such as dollar wages (see Box 3). Regarding its non-BRO trading partners, the story is more mixed. For example, the Kyrgyz Republic faced an almost continuous decline it its relative unit labor cost with respect to Canada, Italy, Turkey, the UK, and the US. However, with respect to Belgium, France, Germany, and Switzerland, the RULC rose until 1998 and then fell in 1999, likely due to the effects of the Russian crisis.

Table 7.

Kyrgyz Republic: Relative Unit Labor Cost, 1995-99 1/

(1995 = 100)

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Sources: National authorities; and Fund staff estimates.

Relative unit labor cost is the ratio of the unit labor cost in the Kyrgyz Republic to that of its trading partner, expressed in dollars. An increase in this index implies a loss of competitiveness.

Dollar Wages in the BRO

Another measure of competitiveness is the average monthly dollar wage, which is easily compared across countries and provides a common measure of labor input costs. Here, dollar wages across the BRO countries are compared to better understand the Kyrgyz Republic’s competitive position with respect to its traditional trading partners.

The Kyrgyz Republic currently has one of the lowest dollar wages among the BRO countries, although this was not always the case. For example, in 1995 the dollar wage in the Kyrgyz Republic was $36 and only the Baltics, Russia, Kazakhstan and Belarus had higher dollar wages. By 1997, dollar wages in most other BRO countries had risen, while in the Kyrgyz Republic dollar wages remained at their 1995 level. This implied an increase in the Kyrgyz Republic’s competitive position as relative labor costs fell. By 1999, the Kyrgyz Republic had the second lowest dollar wage among the BRO countries (only Tajikistan had a lower dollar wage). The fall in dollar wages was mostly due to the sharp depreciation of the som since 1998 and, as is apparent from the Table below, dollar wages fell in several other BRO countries including Kazakhstan and Russia.

Overall, it appears that the trend in dollar wages in consistent with those of the real effective exchange rate and unit labor costs. The Kyrgyz Republic has experienced an improvement in it competitive position with respect to most of the BRO countries. However, it has seen a relative deterioration in its competitiveness vis-à-vis Russia, as Russian dollar wages fell by nearly 50 percent from 1998 to 1999. Thus, the extent to which the Kyrgyz Republic can benefit from a general improvement in competitiveness (measured in dollar wages) is unclear.

BRO Countries: Average Monthly Wage 1995–2000

(In U.S. dollars, period average)

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Source: National authorities.

63. The effects of the Russian crisis also manifested themselves in the RULC with respect to Russia. Between 1995 and 1997 the RULC with respect to Russia fell by nearly 50 percent, only to rise in 1998 and again in 1999. This U-shaped pattern of the relative unit labor cost is consistent with the pattern of the real exchange rate vis-à-vis the ruble and suggests that, since the Russian crisis, the Kyrgyz Republic has suffered a loss in competitiveness with respect to Russia. Conversely, relative unit labor costs with respect to Kazakhstan and Uzbekistan have fallen consistently since 1995, indicating that the Kyrgyz Republic has seen an improvement in its competitive position with those countries.

C. Conclusions

64. Estimates for both a CPI- and PPI-based real effective exchange rate show that, since 1995, the Kyrgyz Republic has experienced an overall improvement in its competitive position. Over this period, the CPI- and PPI-based real effective exchange rates depreciated by about 41 percent and 31 percent, respectively. Much of this depreciation occurred after the Russian crisis, with both measures depreciating by nearly 20 percent since September 1998. In addition, since 1995, the som has depreciated in real terms against the Russian ruble, the Kazakh tenge, the Uzbek sum, the German mark, and the U.S. dollar. Two caveats remain, however. First, since August 1998, the som has appreciated in real terms against the Russian ruble and, although depreciating more recently, has not yet reached its pre-crisis level. Second, the PPI-based real exchange rate vis-à-vis the German mark shows no improvement in competitiveness since 1995; although fluctuations did occur over the period. Estimates of relative unit labor costs show a pattern broadly similar to that of the REER. Thus, the Kyrgyz Republic appears to be in a favorable position to increase its export performance in the period ahead. Nonetheless, the loss of competitiveness vis-à-vis Russia cannot be understated given that it is one of the country’s most important trading partners.

V. Trade Policy24

65. After the dissolution of the Soviet Union, the Kyrgyz Republic engaged in rapid trade liberalization and is now one of the most open economies among the Baltics, Russia, and other countries of the former Soviet Union. In December 1998 it became the first BRO country to join the World Trade Organization (WTO). The purpose of this section is twofold: to detail the process through which the Kyrgyz Republic has chosen to pursue closer integration with the global trading system, and to assess its international trading patterns.

A. Trade Liberalization in the Kyrgyz Republic

Tariff and non-tariff barriers

66. The Kyrgyz Republic is a small open economy, with exports accounting for about 40 percent of GDP, with one of the most liberal trade regimes among the BRO (Table 8). In 1994, the Kyrgyz Republic adopted a uniform 10 percent tariff on all imported goods which remained in place until 1998.25 In 1999, a tariff structure with 12 bands and a maximum tariff of 50 percent was adopted based on its WTO negotiations. The average tariff rate under this structure was 9.18 percent. For 2000, the tariff structure was again simplified to 4 bands with a maximum rate of 20 percent and an average rate of 5.21 percent.

Table 8.

Kyrgyz Republic: Trade Restrictiveness in BRO Countries, 1999

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Source: International Monetary Fund, Trade Policy Information Database.

The overall rating consists of a 10-point scale which weighs a country’s simple average tariff and the extend of non-tariff barriers. Countries with ratings of 1 to 4 are considered to have broadly open trade regimes. Rating of 5 or 6 indicate the existence of moderate trade restrictions. Countries with ratings of 7 to 10 are considered to have restrictive trade regimes.

67. Nontariff barriers for imports consist of fees for services rendered, quantitative restrictions, and import licensing. The Kyrgyz Republic administers an ad valorem customs processing fee of 0.15 percent on all imported and exported goods. Quantitative import restrictions are applied to military arms and goods, explosives, nuclear materials and technology for military use, virulent poisons, and narcotics. Currently, 19 categories of goods, ranging from nuclear materials to tobacco and alcohol, are subject to import licensing. Since July 1998, an import license fee of som 1,000 (about $20 at the present exchange rate) has been applied.

68. The Kyrgyz Republic maintains no quantitative export restrictions other than those specified in an agreement with the European Communities regarding textiles. Export licensing exists for several products including military equipment and precious metals. Export subsidies are not provided, although some exemptions are made for import substitution and export production in the Free Economic Zones. These exemptions are to be eliminated by December 31,2002 according to the terms of the Kyrgyz Republic’s accession to the WTO.

Trade agreements

Regional arrangements

69. The Kyrgyz Republic is a member of the Commonwealth of Independent States (CIS) which consists of all of the BRO countries except the Baltics. In an attempt to restore intra-CIS trade, a free trade area (FTA) was established in 1992. Although import duties are, in principle, not imposed on trade within the FTA, export and foreign exchange controls have hampered an expansion of commerce among some of the CIS countries.26 The coverage of individual goods under the FTA varies and there have been extensive exemptions on a bilateral basis. In addition, weaknesses in the payment system have led to the accumulation of arrears and the reliance on barter transactions, thus further limiting the benefits of freer regional trade. Not surprisingly, the FTA has been generally unsuccessful at reorienting CIS trade inward.27

70. In 1996, the Kyrgyz Republic entered into a customs union with Russia, Kazakhstan, and Belarus, which Tajikistan later joined in 1998. Initially, the members of the customs union negotiated a common external tariff based on Russian tariff rates. However, Russia, Kazakhstan, and Belarus quickly introduced unilateral modifications to the tariff structures, while the Kyrgyz Republic continued to apply a 10 percent uniform tariff rate. Thus, in practice the customs union functions more as a free trade area than a customs union, in that free trade (theoretically) exists between the member countries but no common external tariff is applied. Currently, the Kyrgyz Republic plans to adopt the common external tariff in 2003 (see below).

71. Given the failure of the CIS to boost intra-regional trade and the difficulties with the customs union, questions might arise as to the desirability of further pursuing regional integration; especially given the Kyrgyz Republic’s liberal trade policy stance in comparison with its CIS partners. Indeed, in a paper by Michalopoulos and Tarr (1997), the authors find that FTA’s and customs unions among the CIS member countries are unlikely to enhance growth for two reasons. First, they find that significant trade diversion (rather than trade creation) occurs under these trading arrangement, thus nullifying the benefits of freer trade. Second, they suggest that many of the gains from trade that result in improvements in technology will be missed. This is because preferential trade agreements within the CIS will increase reliance on outdated and inefficient technologies left over from the Soviet era.

Multilateral arrangements

72. The Kyrgyz Republic applied for membership in the WTO in February 1996. In December 1998, it became the first BRO country to join the WTO. (Latvia and Estonia followed in 1999).

B. Accession to the WTO

The process

73. In order to join the WTO, the Kyrgyz Republic was required, like all other applicants, to complete three “phases” of accession: (1) completion of a Memorandum on Foreign Trade Regime which described trade policies and institutions; (2) fact finding by the WTO members; and (3) bilateral negotiations with all WTO members.

74. Each WTO member is entitled to undertake bilateral negotiations for increased market access and reductions in trade restrictions with the applicant. In this sense, the negotiations are unidirectional – only the members make demands during the negotiations. Once the negotiations are concluded, the country is invited to join the WTO.

Concessions

75. Given that the Kyrgyz Republic had a relatively open economy with few trade restrictions and a low uniform tariff, it appears that it did not have to make many concessions to gain membership in the WTO. The primary concession that they agreed to, and which has been difficult to implement involves collection of the VAT. Most CIS countries have adopted a mixed system of VAT collection which is “origin” based for CIS countries and “destination” based for non-CIS countries. The “origin” principle involves payment of the VAT by domestic producers regardless of whether the good is exported or sold domestically. The “destination” principle involves payment of the VAT when the good arrives at its destination, which means that imported goods require a VAT payment and exported goods are tax free. As a requirement for WTO membership, the Kyrgyz Republic agreed to amend its tax code to apply the destination principle to all exports and imports, including those of the CIS, by January 1,1999. Thus far, no such change to the tax code has been implemented since this move will need to be closely coordinated with other CIS countries. In terms of goods and services concessions, the Kyrgyz seem to have made relatively few.28 Concessions on services appear to be limited to the elimination of requirements permitting only Kyrgyz citizens or firms to apply for certain licenses.

Market Access

76. By joining the WTO, the Kyrgyz Republic is automatically entitled to unconditional Most Favored Nation (MFN) status by all other WTO members. However, reductions in trade barriers are only effective if there is significant trade between the countries. Thus, it is clear that for the Kyrgyz Republic, not only their own policies but those of their major trading partners will affect market access and the terms of trade. Unfortunately, four of its six major trading partners are not members of the WTO (Table 9).

Table 9.

Kyrgyz Republic: Trade by Major Trading Partner 1/

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Source: Kyrgyz authorities

Trade is defined as imports plus exports.

77. The pattern of trade that has emerged since 1995 indicates that the Kyrgyz Republic has shifted some trade away from its traditional trading partners and toward WTO members. For example, in 1995 trade with Germany only amounted to 2.2 percent of total trade while by 1999 it had increased to 18.6 percent (although mainly due to gold exports). Similarly, trade with Uzbekistan has diminished from 17.1 percent in 1995 to 9.2 percent in 1999 and trade with the US has nearly tripled from 1995 to 1999. Although trade with Kazakhstan and Russia has declined, these countries still account for the (combined) largest share of the Kyrgyz Republic’s trade.

78. From Table 10, it is apparent that although the Kyrgyz Republic’s traditional BRO trading partners still make up a large share of total exports, this trend is declining. In 1995, Russia, Kazakhstan, and Uzbekistan made up nearly 60 percent of exports. By 1997, that share had fallen to 48 percent, and by 1999 it was only 36 percent. In 1999, non-FSU major trading partners accounted for nearly 41 percent of exports. It should be noted, however, that this has taken place over a period in which total exports have fluctuated significantly. Total exports grew by nearly 50 percent from 1995 to 1997 only to contract, by nearly the same amount, from 1997 to 1999. This reduction in exports over the period 1997–99 is due to the effects of both the Russian crisis and the ongoing trade tensions with Kazakhstan and Uzbekistan (see below).

Table 10.

Kyrgyz Republic: Exports by Major Trading Partner

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Source: Kyrgyz authorities